Foreign Trade Essay

Question: Evaluate the benefits of foreign trade.

A major benefit of foreign trade is comparative advantage. An economy has a comparative advantage in good X if it can produce X at a lower opportunity cost than any other country. As long as economies specialize in their comparative advantage, world output rises and, after international trade, all economies consume more than under autarky. Adam Smith posits that all economies will benefit from foreign trade so long as economies have a different comparative advantage.

However, foreign trade may bring problems like declining terms of trade. An economy could suffer declining terms of trade (export prices divided by import prices) if it specializes in primary products. Over time this means its export prices fall and its import prices rise. So the value of its exports will fall, the value of its imports will rise and its current account moves towards a deficit.

Another reason for countries to engage in foreign trade is to benefit from export-led growth and the global spread of economic booms. Let’s say the USA trades with China. A boom in China means China’s income rises and demand for imports rise so the USA’s exports rise, the USA’s income rises and the USA’s real GDP rises.

On the other hand, an economy could import too many consumer goods, the current account moves towards a deficit, AD falls and real GDP falls. Also, recessions could spread from the global economy to the domestic economy. A recession in China means China’s income falls and demand for imports fall so the USA’s exports fall, the USA’s income falls and the USA’s real GDP falls.

Additionally, foreign trade may lead to an improvement in consumer welfare. Consumer welfare may increase because consumers have access to, and the choice of, goods all over the planet. Consumer surplus may also rise because consumers buy goods from the cheapest countries.

But, there is no guarantee that foreign trade will improve consumer welfare. For example, a global monopoly or cartel could form and restrict output to raise prices. Consumer surplus will then fall because prices are higher.

Lastly, foreign trade could an economy raise foreign currency. Foreign trade allows an economy to earn more foreign currency reserves and use these to repay international debt or import vital capital goods that it may not be able to make domestically.

Although, foreign trade may lead to environmental damage. More trade means more transportation, more aeroplane and shipping usage, more pollution and increased environmental damage.